The Council of Financial Regulators has downplayed the risk of Limited Recourse Borrowing Arrangements (LRBAs) to the financial system and housing market in its December quarterly statement.
In an announcement that will give the SMSF sector some much-needed “Christmas cheer”, the Council takes a benign view of LRBAs after being asked to discuss a report to Government on leverage and the risk to the superannuation system in response to the Financial System Inquiry (FSI).
In its final report handed down in late 2014, the FSI recommended that LRBAs be scrapped, contending that the use of leverage by SNSFs had the potential to destabilise both the housing market and superannuation system.
But the Council says: “The use of LRBAs remains relatively small but has risen over time. Leverage by superannuation funds can increase vulnerabilities in the financial system, though near-term risks have reduced with the shift in dynamics in the housing market.”
In the event, the Federal Government did not accept this FSI recommendation, but there has been an ongoing push, led by the Australian Superannuation Funds Association (ASFA), to deny SMSFs access to this debt instrument.
ASFA’s 2018 Federal Budget submission called for a ban on SMSF borrowing, stating: “Borrowing, even with LRBAs, magnifies the gains and losses from fluctuations in the prices of assets held in funds, and increases the probability of large losses within a fund. This puts individuals’ superannuation at risk.” Industry funds, too, have been critics of LRBAs.
At September 2018, ATO statistics show SMSFs holding $725 billion in total net assets, of which LRBAs, at $42 billion, comprise 5.8%. Although ASFA is correct to note their growth, what critics often fail to state is that the ATO’s decision to change its methodology relating to LRBAs in 2013-14 distorts the percentage increase. Significantly, from September 2017 to September 2018, ATO figures only show a $2 billion increase, a clear indication demand is slackening.
The Council rightly noted that the cooling off in the residential housing market is likely to stem demand for LRBAs. And it could have added that many of the major financial institutions are stepping away from offering this financial instrument.
Criticism of LRBAs has focussed on the residential market, and there can be no denying property spruikers have used LRBAs to entice some unwitting individuals into an ill-advised acquisition. But there has never been any concrete evidence that the practice was widespread, and certainly none to suggest it represented a systemic risk to either the superannuation system or housing market.
And it totally overlooks how it is sensibly used by many SMSF trustees to combine their retirement income strategies with their small commercial operations by placing their business property in their fund and then leasing it back.
Although the Council’s statement will be welcomed by an SMSF sector that has fought long and hard to keep this debt instrument, the fight is far from over with Labor promising to abolish LRBAs if elected.